After the UK’s decision to leave the European Union last June, it became clear that London risked losing its status as Europe’s major financial centre. Several major firms that are headquartered in the City of London, in fact, depend on having a foothold in the European common market. EasyJet, a low-cost airline, famously declared it was going to move only days after the referendum. Being inside the EU gives several advantages, both from a fiscal and a regulatory point of view. Given the circumstances, Europe will need to designate a new financial capital, but what city will it be?
The continent’s three major financial centers – Paris, Frankfurt, and Milan – are lined up to reap the benefits of the post-Brexit exodus. Italy has already moved to start the process of reform to create incentives for firms to come to Milan. If the country continues on that path, there could be conspicuous benefits to its economy and to that of the European Union as a whole.
First, it is worth understanding why it is convenient for firms to move away from London in the wake of Brexit. The City of London has been one of the world’s foremost financial centers for centuries, yet its position was strengthened considerably by being part of the EU. In fact, access to the common market is an immense fiscal incentive. With the UK’s departure from the EU, such an incentive would no longer exist.
The example of EasyJet is particularly telling. As an airliner, its revenues come from several different countries. A plane from London to Madrid, for instance, would include a good portion of residents of Spain and the UK, as well as a number of other countries. Given that EasyJet is based in the UK, EU residents do not need to pay import tariffs on the tickets, thus giving the company access to a large pool of customers at a reduced price. This is because the most basic feature of the EU’s common market is that there are no import tariffs between members. When the UK officially leaves the EU, however, EasyJet will face higher barriers and thus impose higher prices on its customers, which would make demand for their tickets fall. It would be more reasonable for them to resettle within the EU, facing only the UK’s tariffs and not those of the much larger EU market. Furthermore, there is a great deal of uncertainty regarding the replacement of the EU preferential trade agreements for the UK’s non-EU trade, yet another incentive to move to mainland Europe. Indeed, these uncertainties have been clearly picked up by investors, leading to a fairly negative stock performance for the company in recent times.
Yet airlines are just one of the many types of firms that may seek to move. Financial services are probably the biggest industry in question, since they face the same incentives to leave as airlines since their market is global. In fact, according to a City of London report, the UK is the largest exporter of financial services in the world, amounting to more than £47 billion. Indeed, the industry as a whole represents 14.5 percent of the country’s GDP.
Italy is too large of an economy to lose; without it, the continuation of the EU experiment would make little sense. Choosing Milan may therefore well be in everyone’s best interest.
Given the impending flight of firms from the UK, it is now up to other EU countries to enact reforms to position themselves as the best possible replacement. Italy has already commenced its plan for Milan. The Select Milano committee, formed by several important political and financial services leaders, has already fleshed out a plan of action. Surprisingly, for a country that is often beaten by inertia when it comes to economic opportunities, there seems to be considerable motivation for this particular project.
The most basic and important aspect of Milan’s plan is to create a financial district with ad-hoc conditions for the operation of a financial system. Indeed, this was one of the very reasons why the City was able to thrive. The City of London Corporation is a separate entity from the many other neighborhoods of London and was thus able to create specific business-friendly conditions in a clearly defined space. Milan’s plan is based on the same idea. By isolating a financial district, it will be easier to enact the many reforms that are needed, rather than applying them on a city-wide or even national scale.
After these changes, several tax incentives can be put into place. Businesses will be far more inclined to come to Milan if they are offered a more convenient deal. Recently, for example, the Italian parliament produced a resolution asking the government to repeal the Financial Transaction Tax (FTT), which had been in place since 2013. At the time, the European Commission had embarked on an initiative to introduce a common tax on financial transactions for all EU members. Such a tax serves to selectively discourage speculation on certain sorts of transactions and promote price and currency stability by reducing excessive activity. The EC’s proposal was supposed to centralize such regulation for the EU. However, only one country has actually implemented the FTT: Italy. The decision to adopt it came at a time of dire economic crisis when the technocratic PM Mario Monti passed a law to ensure Italy’s economic stability within the EU. As things stand, the country’s financial system is penalized by the increased costs of transactions. A study by scholars at the University of Bologna showed that the intermediary costs of financial transactions are almost doubled by the Italian FTT, which is especially harmful given that investors can easily shift to other EU countries that do not impose the tax. Repealing this tax would therefore be an essential first step for Milan’s bid to become Europe’s foremost financial center, unless in the unlikely chance that the other members suddenly adopt it too.
A second central issue is creating a separate judiciary branch for the financial district. Italy’s courts are known to be overcrowded with cases and remarkably slow at handing out verdicts. Indeed, one of the most significant causes of the current Italian banking crisis has been the fact that, on average, it takes more than six years to resolve a bankruptcy suit. This, in turn, puts a strain on banks’ balance sheets. A specialized arbitration court could be set up to ensure an efficient judiciary option, building on the already-existing Chamber of Arbitration of Milan. This would be very similar to the London Court of International Arbitration, a world leader in the field. By establishing a clear and easy system to resolve legal disputes, Italy could effectively mitigate its country-related risk. This is certainly an area lawmakers will need to concentrate if Milan is to have a real shot.
Another important step is to ensure the presence and quality of specialized human capital. The presence of Bocconi University, a top-ranked economics and business school, certainly helps Milan’s cause. Yet, retaining young brains can be as hard as producing them in the first place. Equally difficult is attracting high-skilled individuals from abroad. To this end, an interesting proposal that has already been articulated as a parliamentary resolution calls for the creation of tax incentives for those who wish to return to Italy from abroad. The idea underpinning this policy is that Italy has very high income taxes, which would create a disincentive for high earners in particular. People in high wage brackets are more likely to settle where a smaller portion of his wage is being absorbed by taxation. Some incentives have already been put into place: the Minister of Economy and Finances Pier Carlo Padoan recently announced the implementation of a flat tax of €100,000 for high net-worth individuals on income from abroad, which experts consider a very good deal.
Reforms are likely to be the cornerstone of any decision with regards to the new financial capital of Europe, and rightly so. Yet the unique circumstances in which the EU finds itself offer a very valid rationale for choosing Milan. With Britain’s farewell, Italy becomes the union’s third-largest economy and amongst its most troublesome. Plagued by almost two decades of sluggish economic growth and a national debt that is amongst the largest in the world, it is a serious threat to the economic stability of the EU. The European Union survived Brexit; it could probably also withstand the downfall of one of its smaller members, Greece or Portugal, for example. Yet, Exita would be the last nail in the coffin. Italy is too large of an economy to lose; without it, the continuation of the EU experiment would make little sense. Choosing Milan may therefore well be in everyone’s best interest.
Some claim that Italy’s unhealthy economy makes Milan an unwise investment decision for the European financial services industry. This is not in itself a problem. What firms may be concerned with, more than economic growth in general, are the causes of such stagnation, many of which are dealt with by the reforms discussed above. Indeed, the central idea of the project is to create a context in which the country-related risk for incoming firms is mitigated by airtight legislation. This does not mean, however, that Italy could not reap the benefits of increased economic activity brought about by an influx of new business. It would be a substantial economic stimulus that could help kick-start the Italian economy. Indeed, one of the most substantial issues for the country since the start of the Great Recession has been weak investment, which is still failing to pick up. An influx of foreign firms would certainly be a significant boost to an economy in need of help.
Perhaps even more importantly, the reforms that Italy could enact to attract foreign firms may also have a structural impact. Indeed, the economic issues it is facing are not merely the result of contingency; there are severe structural issues with the country’s economy, including a byzantine bureaucracy and a crippling system of taxation. The reforms discussed above aim at fixing these issues and may well become a blueprint for national legislation. Milan could be an experiment-city for Italy’s future economic reforms, since starting on a small scale would be advisable from both a cost and practicality perspective. The economic stimulus that would result would in turn help expand the scope of the legislation. Thus, as well as making sense from a European perspective, Milan’s reforms could have considerable positive trickle-down effects for the Italian economy. It is now up to Italian lawmakers to seize this opportunity.